Cullen Speech To Deutsche Bank Conference
Speech To Deutsche Bank Investment Conference
Hon Dr Michael Cullen, Minister of Finance
10.00 am Friday 22 March 2002
Quay West Hotel, Auckland
I am very pleased to have this opportunity to give you my perspective on the recent performance of the New Zealand economy and to describe what I see as the most important features of the economic terrain ahead.
You might say that, as Minister of Finance, it is my job to be an eternal optimist about the New Zealand economy. That is true; but it is gratifying to have, first, good solid reasons for optimism in the form of a good set of economic indicators, and, second, the company of 52% of New Zealanders who, in a recent poll, identified themselves as being optimistic about the economy.
The poll also recording a drop in pessimists to 25%, roughly the number of New Zealanders whose livelihood is derived from the game of rugby. The remaining 23%, I like to think, were out of the country on business.
Turning first of all to the latest economic and fiscal indicators, these show the New Zealand economy to be in very good shape, considering the ongoing reverberations of the September 11 events on the global economy.
The New Zealand economy awoke to the new millennium with a more than slight hangover from the 1990s. During that decade, the growth rate improved, but it was heavily dependent on expanding private domestic consumption. That in turn was underpinned by a dramatic increase in private foreign borrowing, and to some extent by rounds of tax cuts. A strong - some would say overvalued - currency put a lot of pressure on export industries.
The end result was that we closed out the century with high private foreign debt, a balance of payments deficit of around seven percent of GDP, and an export sector that was both demoralised and operating with weakened balance sheets.
Two years into this century, the picture is a lot brighter. The Aspirin is back in the medicine cabinet. The economic indicators are stronger, and more balanced, than they have been since the mid 1960s. The balance of payments deficit has fallen to about 3.5 percent of GDP. Inflation is at 1.8 percent. Unemployment, at 5.4 percent, is close to thirteen year lows. Employment growth is strong, but it has been accompanied by an increase in immigration and a sharp rise in the participation rate which, at 66.4 percent, is the highest it has been in fifteen years.
The government for its part is operating with a fiscal surplus averaging around one percent of GDP, and forecast to rise to nearer 2.5 percent over the next three years. We have held government spending as a percentage of GDP, and it is fractionally lower than it was two years ago. Net crown debt has fallen from just under 22 percent of GDP in 1999 to just under 18 percent now.
The economy grew by 2.6 percent in the 2001 March year, and is forecast to grow by 3.1 percent in the current year. It is likely to taper in the next year to around 2 percent before lifting again to something like a three percent rate in the out years.
In short, today’s numbers reveal an economy that is growing steadily, with low inflation, rising employment, moderate unemployment, and a current account deficit that is very low by recent standards. Real wages and share prices have both risen. Government spending is at prudent levels, with healthy fiscal surpluses, and manageable public debt.
All of this at a time when the world economy has been through one of its more synchronised recessions and confidence has been badly knocked by the events of September 11 last year.
After September 11, all optimism must be cautious. However, when the government published its economic and fiscal updates a week before Christmas there was some comment that the central forecasts were overly optimistic, and that the balance of risk was downside. Commentators pointed to a number of short term risks:
- commodity prices were at record highs, and so it was a long way down to any trough that might be driven by a global downturn;
- investor and consumer confidence surveys showed significant pessimism;
- there was a risk of an emerging drought, which would not only impact on agriculture but risk a repeat of, or even a worsening of, last year’s power crisis;
- the September 11 attacks meant that tourism was particularly exposed, and this was a key component of good recent economic performance.
In the event, these downside risks are largely dissipating, and a number of commentators are now revising up their short-term growth outlook as a result of recent developments and what looks to be better news out of the United States.
The net effect of export and import price changes on the tradeables sector has not been as negative as was feared. Immigration numbers have turned around dramatically, and this has lifted the construction sector. Business confidence is rebounding and the risk we saw of firms retreating into their shells and stopping hiring or investing does not seem to be occurring. Employment was up at the end of last year and new investment is taking place. Consumer confidence is holding up and retail spending is ahead of market expectations. Tourist numbers have bounced back, largely because the composition of tourists has changed. It is raining - too much for the proper enjoyment of summer in fact. And there has been no real implosion or contagion in the global marketplace.
As for the government’s own accounts, the recently released financial statements for the seven months ended 31 January 2002 showed some encouraging trends:
ƒæ Our operating balance for the period was $385 million higher than forecast, due to:
o total revenue being higher than forecast by $248 million;
o total expenses being lower than forecast by $52 million; and
o state owned enterprise and crown entity surpluses being higher than forecast by $85 million.
ƒæ Our net worth was $443 million higher than forecast, due to the improved operating balance and some revaluations of physical assets (which as a matter of policy are not forecast); and
ƒæ Net Crown debt was $278 million lower than forecast due to higher than forecast net cash flows from operations of $246 million, and additional issues of circulating currency of $153 million. (The latter are also not forecast as a matter of policy.)
I am happy to concede an element of good luck in these results. We have had good growing weather at a time when commodity prices, especially for the sorts of commodities New Zealand produces have been at cyclically high levels.
One could hypothesize some causal relationship between economic stewardship by a “wet” finance minister and increased rainfall. However, I cannot claim to have engineered the coincidence of good weather and good prices with a rather large drop in the value of our currency, meaning that we had a competitive exchange rate that allowed other exporters, and the tourism industry in particular, to join in the good times.
Good economic management is an important part of the picture, however. And I would like to expand upon several important themes that are a focus for my government:
- Achieving a better balance in macroeconomic policy;
- Maintaining transparency in respect of the government’s budget;
- A more pro-active role for government in the economy, guided by a commitment to partnership with the business community; and
- A renewed focus on the benefits still to be gained from the Trans-Tasman common market under CER.
- One of the first things that the new government did was to renegotiate the Policy Targets Agreement with the Governor of the Reserve Bank. It confirmed that the primary objective of the Bank was to control inflation, and that was good for confidence. But it also required the Bank to be more sensitive to the impacts of its monetary management on output in the real economy in the immediate term. I think that the Bank would argue that it had taken a tough line in the early stages of the new monetary regime in order to make it clear that it meant business and to discipline expectations. As price setters adjusted behaviour around an expectation of low inflation, it could take a more pragmatic stance. The application of monetary policy had evolved to where the new PTA placed it.
For all of that, formally writing in the new practice did reinforce the bank’s duty to have regard to the effects of monetary policy on the exchange rate, interest rates and output volatility when setting the Official Cash Rate; that is to keep inflation within the target range, but to seek to smooth monetary policy changes where feasible and to recognise that there will be brief periods where headline inflation moves outside the band for good reason. The basic framework - a focus on price stability and the independence of the Governor in making decisions on monetary settings - remained unchanged.
We also commissioned a review of monetary policy and practice, and that has fine-tuned structures and informed practices. We are tending to adopt a medium term focus for the inflation target rather than the point to point target that might have contributed to some of the volatility of the mid 1990s.
Fiscal settings have supported monetary policy. This government has raised the extra money required to cover its extra spending on social and economic development programmes. And it has introduced a scheme to partially pre-fund tax-funded pensions, so that when our demographic structure acquires the inevitable older age profile, there is a cushion to assist in the transition.
This Superannuation Fund will also have three important macroeconomic effects. It will discipline short-term fiscal policy at a time when a favourable demographic structure might otherwise have tempted governments into tax or spending plans that would be impossible to sustain but painful to reverse. It will increase the level of national savings. And finally, it is likely to deepen capital markets.
Another important aspect of economic management - and one that is, by definition, easy to overlook - is the rigorous “no surprises” approach to the government’s Budget. This year’s Budget will be presented to Parliament on Thursday 23 May.
Budgets used to be occasions for intrigue, rumour, speculation and finally grand histrionics on the part of the Minister of Finance, followed by a rush by consumers to stock up on liquor, cigarettes, petrol or US bonds, as the situation required. Now the process is completely demythologised, and most importantly Budget announcements carry no rude surprises and rarely have any measurable impact on the markets. We have left the theatrics to our performing arts industry, and now have a budgetary regime that provides more or less continuous disclosure through regular fiscal updates.
I want to focus for a while on this government’s move away from a passive role in the economy. The late 80s and 90s was the era of the “neutral referee” model of intervention. It was preferable to the crude attempts to rig economic results that preceded it; and has bequeathed to us a set of economic playing fields that are some of the flattest in the world. But as a neutral referee government increasingly found itself presiding over a series of tepid nil-all draws.
This government is developing an “active promoter” approach, characterised by smarter activism. To continue the sporting analogy, we are looking to fill the stands and we recognise that what will ultimately do this is fitter players, systems for developing young talent, good teamwork, clever strategy and better promotion.
I could cite from a growing list of examples of this “smart, active” style: initiatives in dealing with skill shortages, upgrading the regulatory environment that applies to the electricity and telecommunications sectors, supporting the development of e-commerce, improving the funding of research and development, and simplifying the tax treatment of private sector R&D.
There are two important features of the government’s method:
ƒæ First, it is pragmatic and case-by-case, as evidenced by the consolidation of the dairy industry on the one hand, and the deregulation of the apple industry on the other. Each was a considered response to some careful analysis of the industry concerned and the global marketplace.
ƒæ Second, creating and maintaining working partnerships between government and the business sector is at the heart of the strategy. There is no long-term value in unilateral action by government in economic development, even if it draws upon the best analysis available.
I would like to touch on two examples of this partnership approach. My government has for the last few months been in discussion with the financial services sector on ways to improve the application of GST to the sector. Because financial services are inherently difficult to value, they tend to be over-taxed in countries that have value-added taxes. At present, financial institutions in New Zealand, as in many other countries, cannot claim GST refunds on most goods and services they purchase. This is because the services they supply are exempt from GST. To compensate for their inability to claim refunds, they must absorb the cost or raise their fees. The businesses to whom they provide services cannot recoup the cost, so they pass it on to the consumer. This situation is often referred to a tax cascade. As a consequence of our discussions, we are proposing that supplies by the financial sector to registered businesses be zero-rated. This will mean that these transactions are treated in the same way for GST purposes as non-financial transactions, while at the same time removing the valuation difficulties. It is not an easy measure to design, and the details of the proposal are still being developed. I am confident, however, that the government and the financial services sector can together design a workable regime.
My second example of the partnership approach is the strategy “Growing an Innovative New Zealand”, as set out in the report of that name. This is a comprehensive programme aimed at lifting our game, and raising our sustainable growth rate through innovation.
Unlike traditional innovation strategies, it does not place the emphasis solely on economic results, leaving social dividends to flow at a future undefined time when they can be afforded. Instead it lays out a pathway where social development and environmental protection not only rank alongside economic growth, but where they actually become agents of that growth.
Secondly, the strategy blends what I would call the vertical and horizontal dimensions of innovation. The horizontal dimension of innovation recognises that there are aspects of New Zealand’s environment, industry-clusters, national aptitude and attitude where the potential of the global market coincides with the potential of New Zealand to sell into it. We have identified three areas where there is a good fit: biotechnology, information and communications technology, and creative industries.
It is important to stress that we are not trying to pick individual industries as winners. Instead, innovative advances in these areas have the potential to complement each other and to thicken value added in a number of industries that use or could use these technologies. In other words, they are sectoral competencies that have multi-industry applications.
The vertical dimension is about addressing missing or weak links in the “chain” of innovation. Hence we improve our scientific and product development capacity. We nurture ideas through appropriate support systems, so that the full range of business disciplines - legal, accounting, financial, logistical and so on - are brought together to convert good ideas into profitable enterprises. We seek increased foreign direct investment, in particular in the biotechnology, information and communications technology, and creative industries. Vertical innovation clears the path for young plants to grow; while horizontal innovation creates “hybrid vigour” by applying new technologies and ways of thinking across both old and new industries.
To move to my final theme, my recent discussions with political and business leaders in Australia illustrated the growing interdependence of the two economies. There is untapped value in our combined economy.
The increased awareness of this in Australia is partly a response to September 11; but also to the acquisition of some major Australian companies by foreign interests. The prospect of becoming a branch economy of the United States, with “hollowed out” companies exercising a major influence on the country’s economic well-being, is something both Australia and New Zealand now share. Part of the answer is to build a web of Trans-Tasman companies with a firm base in our common market.
Government is playing its part with ongoing coordination of business law and alignment of tax regimes. In many areas New Zealand is taking unilateral action to make sure its own business law is compatible with Australia’s. Our recent Takeovers Code has many features in common with the Australian code, and Australian law is informing our approach to the control of insider trading. And while the proposal to merge stock exchanges has fallen by the wayside, the Australian government has recently invited our government to develop proposals for the mutual recognition of securities offerings. I am hopeful that the work now starting will result in reduced compliance costs for cross border securities offerings and give investors in both countries increased investment options.
As I said at the outset, I have very sound reasons for optimism about the New Zealand economy. It is easy to become very sensitised to the risks in the international political, financial and trading environments. And we can easily downplay the positives that are out there, and take for granted our own strengths. We share with other democracies the well functioning legal, financial and political institutions that make us well placed to respond effectively to shocks, both political and financial. Technology is opening up both new opportunities and methods to deal with old problems.
At the risk of speaking too soon, I would argue that New Zealand has weathered the global slowdown and the post 11 September storms better than most. We have learned to deal with the twin challenges of distance from our markets and a relatively small domestic economy. In fact, these disadvantages of location and scale are being turned on their heads, and we emerge increasingly as a safe but also profitable location for investment, tourism and lifestyle.